Why might it be advisable to keep student debt vs. paying it off quickly?

But I have a friend named A who has a friend named B who is a financial advisor (a young so therefore perhaps ignorantly malicious one). B has convinced A that he should take a very long time to pay off his student loans.

This makes no sense to me. Even if your money can be invested to produce value faster than your debt will accrue interest, there are still obvious problems. For example, if you lose your job, you’re potentially in trouble. Any financial setback could turn into a terrible credit score.

Is there some reason somebody would and should willingly take a long time to pay off student debt and why?

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13 Responses to “Why might it be advisable to keep student debt vs. paying it off quickly?”

This loan can’t be taken out of context. By the way, how much is it? What rate? “Debt bad.” Really? Line the debt up. This is the highest debt you have. But, you work for a company that offers a generous match, i.e. the match to your 401(k). Now, it’s a choice, pay off 6% debt or deposit that money to get an immediate 100% return.

Your question has validity. In the end, we can tell you when to pay off the debt. After –

Your 401(k) match is max’ed.

When your higher rate debts are paid.

When you have a sufficient emergency fund.

The issue is that you are quoting a third party without having the discussion or ever being privy to it. In court, this is called ‘hearsay.’ The best we can do is offer both sides of the issue and priority for the payments. Welcome to Money.SE, nice first question.

I’m no financial advisor, but I do have student loans and I do choose to pay them off as slowly as I can. I will explain my reasoning for doing so. (FWIW, these are all things that pertain to government student loans in the US, not necessarily private student loans, and not necessarily student loans from other countries)

At 5%, my student loans are super low interest compared to some of my
other debts making it much more profitable to ignore in favor of paying off
things with higher interest.

Student loans (at least in the US) tend to have incredibly low minimum payments. Mine are $55 per month, which means I am not in any kind of rush to pay off that debt so I can put that money elsewhere.

Student loans (at least in the US) are super low pressure loans. Despite it only being $55, if I can’t make a payment one month I can call and tell them and they will allow me to put off that month’s payment at no detriment to myself other than adding an extra month to the end. They would allow me to do this every month forever if I wanted to. (additionally, even if I didn’t call them to tell them, there are no late fees and they will almost never default)

There is a program (at least in the US) where if you pay your student loans on time for 20 years then you can apply to have the rest of them waived. (it used to be 25 years, but was changed to 20, or 10 if you work in public service, with the Health Care and Education Reconciliation Act of 2010)

So that’s my reasoning. $55 per month for the rest of my life adds up to a large amount of money over the course of my life, but the impact month-to-month is essentially nonexistent. That combined with the low interest and the super-low-pressure-sales-tactics means I just literally don’t have any incentive to ever pay it all off. Like I said before, I’m just a guy who has student loans, and not even one who is particularly good with money, but as someone who does choose not to pay off my student loans any faster than I have to, this is why.

Like all other loan-vs-savings questions, it depends on the terms of the loan.

If you have a choice, the usual answer is to pay off the loan with the worst terms (which usually means the highest interest rate) first, and only start with savings when you’ve paid off all the high-interest loans entirely.

If your student loan is on US terms, then pay it off as soon as you can, unless you have commercial debt (credit-card or unsecured personal loan), which you should pay off first, or unless you have or are realistically likely to get eligibility for a forgiveness program.

But it does depends on the terms of the debt, which in turn depend on the country you studied in; on UK terms it’s a very bad idea to pay off a student loan any faster than you have to. Interest is restricted to the rate of inflation, so good investments probably beat the interest rate of the student loan; the required repayments vary with your income, so savings are more useful than debt repayment if you encounter income difficulties (e.g unemployment) in the future, and finally the debt is automatically forgiven after 30 years, so you may never have to pay it all back anyway – so why pay it off voluntarily if it would get forgiven eventually anyway?

There are a great number of financial obligations that should be considered more urgent than student loan debt. I’ll go ahead and assume that the ones that can land people in jail aren’t an issue (unpaid fines, back taxes, etc.).

Any accounts in collections. Get rid of this poisonous debt immediately, either by disputing it if it’s wrong or biting the bullet and paying it off.

Revolving debt. Credit cards, especially store-specific cards, will have a higher interest rate even if the minimum payment is lower. If you purchased something with a limited term, no interest deal (as they often offer), just make sure you pay it off before the term is up, otherwise they’ll drop all that accrued interest right on top of your balance.

Savings. This is a big one, and I am appalled that, as of this writing, nobody has yet mentioned it directly. If you don’t have at least three months of savings to replace your income in the event of job loss or injury or unexpected medical or auto-related expenses, then put the extra money you would have put toward your student loans into a “high-yield” (or what passes for one these days) savings account. There are a couple online accounts that earn around 1% at the moment. Yeah, it won’t cancel out the interest you pay on the student loan, but this is so much more important.

I cannot stress this enough, so I’ll say it again: setting money aside for emergencies is so much more important than paying off student loans. I’ve seen people refer to saving as “paying yourself” if that helps justify it in your mind. My wife and I chose to aggressively pay down debt we had stupidly accrued during college, and I got completely blindsided by a layoff during the downturn. Guess what happened to all those credit cards we’d paid off and almost paid off? Guess what happened to my 401k?

If all we had left were student loans, then I still wouldn’t prioritize paying those off. There are income limits to Roth IRAs, so if you’re in a field where you’ll eventually make too much to contribute, then you’ll lose that opportunity forever. If you’re young and you don’t feel like learning too much about investing, plop 100% of your contributions into the low-fee S&P 500 index fund and forget it until you get closer to retirement. Don’t get suckered into their high-fee “Retirement 20XX” managed funds.

Anyway, sure, if you have at least three months of income replacement in savings, have maximized your employer 401k match, have maximized your Roth IRA contributions for the year, and have no other higher interest debt, then go ahead and knock out those student loans.

You become a teacher; generally K-12, but I have heard from the DOE
that teachers at state schools qualify as well.

This is not 100% correct.

Teaching in certain disciplines and areas (STEM, Special Education, Title 1 schools) can qualify for student loan debt forgiveness DEPENDING on the type of debt. For instance, I believe the Federal loan forgiveness program only covers debt remaining after 10 years of teaching in a qualified discipline. Do verify this as it’s been several years since I looked into the matter.

The DOE has a student loan forgiveness program, but the scope of it is somewhat narrow. I would encourage anyone considering this approach to investigate it in detail before committing to a career in teaching.

Some states have similar programs, but they typically have limitations as well.

Two different questions: Is it better to be in debt or to pay off the debt? And: Is it better to have student debt than other debt?

Any debt needs to be paid off eventually, and any debt makes you less flexible. So if you have the choice between spending/wasting your money and paying off debt, I would recommend paying off the debt.

The other question is whether having student debt is better than having other debt. You need to look at the terms of your student debt. Pay off the debt with the worst conditions first. Loan sharks (in Britain: pay-day loans) must be paid first. Credit cards debt must go next. Then general loans.

Depending on your situation, you may want some savings as well. In case you lose your job, for example. So if you have $8,000 saved and an $8,000 student loan, you might consider waiting a bit before you pay back the loan. No job + $8,000 student loan + $8,000 in the bank is better than no job + no debt + no money in the bank.

A Tweep friend asked me a similar question. In her case it was in the larger context of a marriage and house purchase. In reply I wrote a detail article Student Loans and Your First Mortgage.

The loan payment easily fit between the generally accepted qualifying debt ratios, 28% for house/36 for all debt. If the loan payment has no effect on the mortgage one qualifies for, that’s one thing, but taking say $20K to pay it off will impact the house you can buy. For a 20% down purchase, this multiplies up to $100k less house. Or worse, a lower down payment percent then requiring PMI.

Clearly, I had a specific situation to address, which ultimately becomes part of the list for “pay off student loan? Pro / Con”

Absent the scenario I offered, I’d line up debt, highest to lowest rate (tax adjusted of course) and hack away at it all. It’s part of the big picture like any other debt, save for the cases where it can be cancelled.

Personal finance is exactly that, personal. Advisors (the good ones) make their money by looking carefully at the big picture and not offering a cookie-cutter approach.

Say you have $50k in student loan debt. You come into a large amount of money and throw $10k at it. Yes, it’s now down to $40k, saving you a lot of money in interest over the long run, but it’s money you can no longer ‘use’.

Now if you invest that same $10k instead, you still potentially have access to it if needed.

Paying $10k towards a debt at a 5% interest rate has essentially the same rate of return as investing the $10k at a 5% return. You’re ‘making’ the same amount of money either way. But if you say, get laid off or need money for medical expenses or a down payment on a house, you can tap into that $10k investment if needed. It is a liquid asset.

If the interest rate on the student loan is lower than inflation, then the student loan will be “cheaper” the longer you take to pay it.

This is now a very rare instance, but there were programs and loan consolidation opportunities in the mid-200x’s that allowed savvy student’s to convert their loans to have an interest rate of around 1.5%.

Right now the inflation rate is actually quite low, but it’s not expected to stay there, and wasn’t that low just a few years ago, so in the long run this type of debt will only be cheaper the longer it takes to pay off.

It is risky, as others point out, as it can’t be written off in bankruptcy, but there are other situations where it can be written off more easily than other debts, so on balance the risks aren’t better or worse than other loans in general. For specific individual situations the risk equation might work out differently, though.

Further, student loans aren’t considered traditional debt by some lenders for specific lending opportunities, thus allowing you to go into greater debt for certain types of purchases. Whether this is good for you or not depends on the importance of the purchase. If you need to buy a house and the interest rate is higher than your student loan rate, it will be better, financially, to pay off the house first, while paying the minimum on the student loans.

If you have no other debt with a higher interest, and the student loan interest is higher than inflation, there is no reason to delay paying off the student loan.

There are several ways you can get out of paying your student loans back in the USA:

You become disabled and the loan is dismissed once verified by
treating doctor or the Social Security Administration.

You become a peace officer.

You become a teacher; generally K-12, but I have heard from the DOE that
teachers at state schools qualify as well.

So the “malicious” friend B is prescribing to the theory that if one of those conditions becomes true, friend A will not have to pay back the loan. The longer you drag it out, the more chance you have to fulfill a condition. Given that 2 of these methods require a commitment, my guess is that they are thinking more along the lines of the first one, which is horrible.

Financially, it makes no sense to delay paying back your loans because deferred loans are only interest-free until you graduate and are past your grace period, after which they will begin accruing interest. Unsubsidized loans accrue interest from the day you get them, only their payback is deferred until you graduate and exhaust your grace period. Anytime you ask for forbearance, you are still accruing interest and it is capitalizing into your principal — you are just given a chance to delay payback due to financial hardship, bad health, or loss of job. Therefore, at no point are you benefiting beyond the time you are in school and getting an education, still looking for a job, or dealing with health issues.

In the current market, no CD, no savings account, and no investment will give you substantially more return that will offset the loss of the interest you are accruing. Even those of us in the old days getting 4.X % rates would not do this. There was a conditional consolidation offer the DOE allowed which could bring all your loans under one roof for a competitive 5.x-6.x % rate allowing you a single payment, but even then you would benefit if you had rates that were substantially higher. From a credit worthiness aspect, you are hurt by the outstanding obligation and any default along the way, so you really want to avoid that — paying off or down your loans are a good way to ensure you don’t shoot yourself in the foot.

One of many things to consider is that in the United States student loan interest is tax deductible. That fact could change the math enough to make it worth putting A’s money elsewhere depending on his interest rate and income bracket.

Congratulations for achieving an important step in the road to financial freedom.

Some view extending loan payment of loans that allow the deduction of interest as a good thing. Some view the hit on the credit score by prematurely paying off an installment loan as a bad thing.

Determining the order of paying off multiple loans in conjunction with the reality of income, required monthly living expense, and the need to save for emergencies is highly individualized.

Keeping an artificial debt seems to make little sense, it is an expensive insurance policy to chase a diminishing tax benefit and boost to a credit score. Keep in mind it is a deduction, not a credit, so how much you save depends on your tax bracket.

It might make sense for somebody to extend the loan out for an extra year or two, but you can’t just assume that that advice applies in your situation.

Personally I paid off my student loan early, as soon as it made sense based on my income, and my situation. I am glad I did, but for others the opposite made more sense.

I see two advantages to not paying student loan debt off more quickly:

To build credit.

To hold your debt at a lower interest rate while you pay off higher interest rate debt. (For example, if you have a student loan at 2.9% fixed interest but also carry another compound interest loan at 5.9%, you may want to pay off the 5.9% interest loan first.)

For #1, however, there are plenty of other ways to build credit and I don’t see this as being worth the downsides of not paying off the debt more quickly. In fact, in the United States student loan debt cannot be written off if you go bankrupt. This is important to know and understand.

I would generally advise you to pay down your student loans as quickly as you can reasonably do so.